Prepayment Privileges and Prepayment Penalties

Prepayment privileges are important features of a mortgage. These are the particular circumstances under which you can make additional payments on your mortgage penalty free. Typically most lenders have the following types of prepayment options:

Lump Sum Payments

• This is usually expressed as a percentage of the original principal of the mortgage that can be paid each year.

• Some lenders calculate this period to be from calendar year to calendar year, some lenders calculate this period from anniversary date to anniversary date.

• Usually the terms range from 10-20% of the original principal.

Increase in Regular Payments

• This is usually expressed as a percentage increase of the contracted monthly payment.

• The increased allowable amount can range from 10-20%, or even up to 100% of the original payment.

• Most lenders also allow you to increase your payments by switching to a bi-weekly accelerated or weekly accelerated payment schedule in addition to your prepayment privileges.

Other special programs

• Skip a payment.

• Double your payment.

Prepayment Penalties

This is the penalty you will need to pay if you choose to break (or payoff/transfer/refinance) your closed term mortgage before its maturity date. A few limited featured mortgage products with certain lenders do not allow you to break the mortgage at all unless you have sold the property, it is important that you know if your mortgage can be paid off prior to maturity or not.

These are the two most common methods for calculating a prepayment charge on a fixed term mortgage; typically most lenders state that their penalty is the higher of:

• Three months’ interest: an amount equal to three months’ interest on your outstanding mortgage balance.

• Interest rate differential (IRD): an amount based on the difference between two interest rates. The first is the interest rate for your existing mortgage term. The second is today’s interest rate for a term that is similar in length to the time remaining on your existing term. For example, if you have three years left on a five-year term, your lender would use the interest rate it is currently offering for a three-year term to determine the second rate for comparison in the calculation.

Not all lenders calculate their Interest Rate Differential (IRD) calculation the same.

Some lenders may use the posted (or advertised) interest rate at the time you signed your mortgage agreement and compare this to the current posted rate for the term remaining.

Other lenders may use your actual discounted interest rate but also apply the discount to the current rate for the comparison. In this case, the difference in rates remains the same as if posted rates were used and the results of the calculation will be very similar.

Some lenders may use your discounted interest rate for your existing term but will not apply the discount to the posted interest rate used for comparison. This will usually result in a lower prepayment charge.

Options 1 and 2 above, using the posted rate as the comparison rate, or adding back the discounted rate both result in a higher cost to you if you break your mortgage. If all else is equal, we would usually recommend a mortgage from a lender where the prepayment penalty is based on the lower calculation method in option 3. Many factors are considered when choosing a lender, sometimes because of more beneficial interest rates or because of certain approval criteria, a lender with the 3rd method of calculation is the best choice for your mortgage. This is a good discussion to have with your Mortgage Brokers Ottawa agent.

Most lenders calculate the prepayment penalty on a variable rate mortgage to be three months’ interest.